Saturday, August 27, 2011

Let the Fed make your payments.

When people are deleveraging, more of our income goes to paying off debt. Less of our income remains for other things. Less remains for going out to dinner, and for buying toys, and for keeping the AC cranked up in the summer and the heat turned up in the Winter. Less money for other things. This is where the deflation comes from.

In order to prevent the deflation, it is necessary to continue with the normal spending that we were doing before we started deleveraging. And that is the problem. For if the money goes to normal spending, then it cannot go to deleverage. And if it goes into deleverage, then it cannot go to normal spending.

What are the solutions to this dilemma?

1. Improve confidence, reducing the urge to delever. This pathetic joke of a policy is the policymaker's main avenue of hope today. But it does nothing to reduce the target of deleverage: It does nothing to reduce debt. If there was no debt, there would be nothing to delever, and normal spending would resume.

If we wait long enough, however, delevered spending becomes the new normal. Reduced spending becomes the new normal. Depression becomes the new normal. We are moving toward this, more and more. This is why there was urgency at the start, and why there is less hope for quick improvement today.

2. Increase income by some magic. If we are going to maintain a level of normal spending and at the same time engage in deleveraging, then we need additional income. This is the reason that various groups call for various tax cuts -- for the middle class, or for the rich, or for the payroll.

Tax cuts, however, reduce revenue to government, making the problem of deficits worse. Then, cuts to government spending compound the downward spiral. Hopes come to rest on "confidence" and "certainty" at a time when we have neither. And none of this has the slightest bearing on the private sector's desire to reduce its own debt.

3. Let nature take its course. Deleverage drives down normal spending. This reduces growth, creates recession or depression, reduces the quantity of money in circulation, and leads to deflation and lowered incomes.

When lowered incomes confront existing debt, debt casts a longer shadow. It enhances incentives to deleverage. It reduces growth, creates recession and depression, reduces the quantity of money in circulation, and leads to deflation and lowered incomes.

When lowered incomes confront existing debt, debt casts a longer shadow...

4. Decrease debt by some magic. Forgiveness would work. Default would work. Both of these are disruptive to creditors, I think. Could be wrong about that. But if these methods were not disruptive to creditors, we would probably have done them already.

The Arthurian solution comes under category 4: Print money and use it to pay off debt for people. Those mortgages that became a problem, that created the subprime crisis that created the financial crisis that created the economic crisis... I say let's get rid of those mortgages.

The Fed bought up a lot of risky mortgages a while back. If they still own any, they should forgive that debt immediately. They should have forgiven that debt when they bought it. With that debt forgiven, under-water homeowners suddenly don't have a mortgage payment every month. Suddenly they have a healthy chunk of extra cash, every month. That cash will want to go for normal spending. Assuming it's not too late to preserve normal spending, this helps to eliminate the threat of deflation.

There is still plenty of debt in the economy that the Fed didn't buy up. We still need to reduce this debt. So, let the Fed print money and use it to pay it off. Let the Fed make your payments.

When they print money, that's bad because it causes inflation. Sure. But when you pay off debt, that causes deflation because it destroys money. So when we print money and use it to pay off debt, we create new money and destroy it immediately. Destroy it by reducing debt. Destroy that new money, instead of taking existing money out of circulation. Destroy the new money, destroy the threat of inflation, and destroy debt without reducing the normal spending that our economy needs and we need.

Take advantage of being off gold. Print money and use it to pay off debt.

1 comment:

Jazzbumpa said...

My take on the 4 options:

1) Change confidence to growth, and you have the formula for the Fed debt post WW II. We never reduced the actual amount, we just made it smaller relative to our ability to pay. But now everything is austerity and contraction - negative social mood.

2) Increase income - we haven't done that at the working level in 40 years. It aint gonna happen now.

3) Nature's course - the Andrew Mellon do-nothing approach from the 30's. You described the process. It is painful - quite unnecessarily so - and at our debt levels will take decades. People will not willingly starve. This way there be blood in the streets.

4) Default/forgiveness. This isn't magic. It is the historically traditional way to save society from the ravages of option 3. The huge policy mistake we have made in recent decades is to protect creditors at the expense of debtors, and society in general. Profitizing the gains while socializing the losses has been part of this. Look at Ireland. They socialized internally the losses that properly belong to external creditors.

These 2 links refer to the same original article. Check them both, and click through. The entire edifice of economics is based on fallacies.